How Both Sides Wound Up Losing Budget Battle

Jan. 7 (Bloomberg) -- A grand fiscal bargain, with perhaps
$2 trillion more in deficit reduction over 10 years -- more than
a quarter of which would be additional revenue and much of the
rest obtained through well-crafted, significant cutbacks in big-ticket entitlements -- could have been a win-win for Republicans
and Democrats.

Along with ending the tax cuts passed under President
George W. Bush, this would have earned lawmakers public
approbation for working together and given investor and business
confidence a boost.

The corollary is the small-bore deal cobbled together to
avoid the so-called fiscal cliff, which may be a lose-lose for
both sides. Defying political physics, the White House and
congressional Republicans emerged politically weaker and facing
more trouble ahead.

President Barack Obama, who Republicans acknowledged had
all the leverage in the latest round, could have hung tough and
persevered with one goal: the bigger deal. Indisputably,
Democrats got much more than Republicans. Yet even with this
unusual leverage -- without a deal, taxes would have increased
for everyone -- the Democrats only got about 60 percent of what
House Speaker John Boehner had once been willing to give on
taxes.

Republicans reinforced their image as protectors of the
privileged. In the House, which they control, they displayed
dysfunction remarkable even by Washington standards. With bigger
fights ahead over the debt ceiling and indiscriminate across-the-board spending cuts, the problems outweigh the possibilities
for both sides.

Estate Tax

The estate tax epitomizes this state of affairs. It is
assessed on less than 1 percent of the richest estates. Michael
Graetz, a former Treasury official in the George H.W. Bush
administration who has written a book on the subject, says that
with huge deficits and worsening income inequality, “it is
amazing that our political system cannot maintain an estate tax
that contributes less than 1 percent of federal revenues from
those Americans best able to afford it.”

Former Treasury Secretary Larry Summers once observed,
“There is no case other than selfishness” for cutting the
estate tax.

There are legitimate debates about the effect on economic
growth of tax rates on capital gains, dividends or corporate
income. It’s tough to find a serious economist who makes that
case for the estate tax; years ago, the conservative economist
Irwin Stelzer described a low tax as “affirmative action” for
wealthy heirs.

Still, reducing or eliminating the estate tax was a top
priority for Republicans in this latest round. The White House
essentially caved to a measure that will cost about $100 billion
over 10 years and will benefit fewer than 5,000 wealthy estates.

In the 2010 year-end tax-cut deal, the Obama administration
insisted on extending the refundable tax credits for the poor;
resistant Republicans said they would go along only if the White
House accepted two years of lower estate-tax rates. Agreed. This
time, however, the refundable credits for the poor were only
extended temporarily, while the more generous estate-tax
provision is permanent.

The political appeal here is to reward big campaign
contributors; that matters to Democrats as well as Republicans.
When Vice President Joe Biden, in the private bargaining, argued
for a tougher provision, the Senate Republican leader, Mitch
McConnell, asked that it be put to a vote. The vice president
knew that Democrats such as Senators Max Baucus of Montana and
Mary Landrieu of Louisiana would side with the rich heirs.

Debt Ceiling

Lawmakers are braced for a tougher battle in the next two
months over the debt ceiling and across-the-board spending cuts
that neither side likes. Republicans contend that, unlike the
fiscal cliff -- -- the tax increases and spending cuts that had
been set to take effect in 2013 --- this time they have the
leverage to force the president to accept big spending cuts,
particularly of big-ticket entitlements.

House Republicans insist on the “Boehner rule,” that any
increase in the debt ceiling be matched by a comparable
reduction in spending. That isn’t realistic: The debt ceiling
will have to be increased by almost $2 trillion over the next
two years, and spending cuts of that order would be politically
and economically disastrous. The speaker’s ability to maneuver
may be limited, though. On the fiscal deal, his own majority
leader and whip deserted him, as did seven current committee
chairmen and almost two-thirds of his caucus.

Tougher still is the substance. House Republicans are all
for big spending cuts, though other than some easy ones, such as
going after programs for the poor, they duck specifics. They are
fierce deficit hawks in principle, yet when specific Medicare or
Social Security cuts are raised they turn into pacifists.

And the president, who wouldn’t play for keeps when he had
the leverage, vows this time will be different. He won’t
negotiate over the debt ceiling; that would be tantamount, he
proclaims, to negotiating with terrorists.

Obama demands that any spending cuts be accompanied by
revenue increases. He correctly notes that there already has
been more than twice as much in spending cuts as in tax
increases and that any subsequent action that involves only cuts
would run counter to the recommendations of bipartisan panels
such as the 2010 commission headed by former Republican Senator
Alan K. Simpson and Erskine Bowles, a former White House chief
of staff under Bill Clinton. Republicans dismiss that as a
nonstarter.

The bottom lines: The White House believes Republican
leaders privately realize that holding the nation’s full faith
and credit hostage to cutting popular programs is a loser.
Congressional Republicans dismiss Obama’s lines in the sand,
saying he invariably backs down and that any economic fallout
ultimately hurts his presidency.

Both points are persuasive.

(Albert R. Hunt is a Bloomberg View columnist. The opinions
expressed are his own.)